Property development finance: how development loans work

The main alternatives to a senior development loan are bridging finance for lighter projects, mezzanine finance or a joint venture to reduce the equity needed, and borrowing against property you already own; for change-of-use schemes, conversion finance may be a better fit.

• Bridging loans: short-term secured funding to buy quickly, fund light refurbishment or bridge a gap before longer-term finance.
• Auction finance: a form of bridging arranged to meet the tight completion deadlines of auction purchases.
• Mezzanine finance: a second-charge loan behind the senior development loan, reducing the equity you need. It costs more because it carries more risk.
• Joint venture finance: a funding partner provides much of the capital in return for a share of the profit.
• Secured business loans: borrowing against existing property to raise a deposit or fund further schemes, with that property at risk if repayments are missed.
• Commercial mortgages and portfolio finance: long-term borrowing to buy, hold or refinance property, often used as an exit.

Development finance is available to experienced developers and, on smaller schemes, first-time developers who can show planning, a viable appraisal, a deposit, a capable professional team and a credible exit. Lenders look at:

• Experience: your track record of similar projects. First-time developers can still be funded, often with a stronger deposit, a smaller scheme or an experienced professional team.
• Your contribution: evidence that you can fund the deposit and cover cost overruns.
• Planning: most lenders want planning permission in place before build funds are released.
• The numbers: realistic build costs, a contingency, the GDV and the expected profit margin.
• The professional team: contractor, architect and project manager.
• Exit strategy: evidence of demand, comparable sales or a refinance route.
• Credit history: of the borrowing company and its directors.

The same scheme can be viewed quite differently from one lender to the next. Some development lenders prefer small residential schemes and first-time developers; others only consider larger or commercial projects, want a named main contractor on a fixed-price contract, or will not lend until planning conditions are discharged. Matching the scheme to lender appetite early saves time on valuations that go nowhere.

Development finance usually involves interest plus fees, such as arrangement and exit fees, valuation, monitoring surveyor and legal costs. Pricing depends on your experience, the loan to cost and loan to GDV, the scheme's risk and market conditions. Always look at the total cost of the facility across the project, not just the headline rate.

Development finance is secured by a first legal charge over the site, so the land and the building as it is constructed are the lender's main security. Most lenders lend to a special purpose company set up for the scheme and take a debenture over it as well. Personal guarantees are often required. Many lenders limit them to a share of the loan, but they may also ask for cost overrun or completion guarantees, so check exactly what you are signing. Where a mezzanine lender is involved it takes a second charge, and the two lenders sign an agreement setting out who ranks first. If your deposit is short, some lenders will accept a charge over other property you own instead. Our guide to debentures and fixed and floating charges explains what is registered.

• Benefits: take on larger projects than your own capital allows; keep cash free for other opportunities; pay interest only on drawn funds; improve your return on the capital you put in.
• Risks: build cost overruns and delays eat into profit; property values can fall before sale; the site is security, so failing to repay risks losing it.